The Week Ahead: How Sorry Will May Sellers Be?

Mantras can be prophetic until they aren't, and those who "sold in May" have already lost out on solid gains. However, several sectors continue to look good for buying, writes MoneyShow's Tom Aspray.

The financial markets finished the week with solid gains, as the ECB and Fed’s action was better than the markets expected. This had been a primary concern of many and had kept them out of stocks.

The Spyder Trust (SPY) closed up 1.9%, while the SPDR Diamond Trust (DIA) gained 2.1%. Even more impressive was the Russell 2000, as the iShares Russell 2000 Index (IWM) was up 2.6%.

Technology stocks had been leading the charge for the past month, but last week the Nasdaq-100-tracking PowerShares QQQ Trust (QQQ) as was up only 1%.

As I noted last Friday, there has been significant improvement in the technical picture this week, as the market internals improved sharply. Therefore, the coming correction should present a buying opportunity for higher prices into the end of the year.

Last spring, the media was focused on "sell in May,” which over the past few years has been an increasingly well-known mantra. As it has become more popular, many analysts have correctly pointed out the weaknesses in this approach. Nevertheless, after 2010 and 2011, many likely did sell in May, which they are likely now regretting.

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These charts show what profits may have been lost for those who either sold at the end of April or at the end of May but have not reinvested. Someone who sold their position in the Spyder Trust (SPY) at the end of April would have given up around 5.4% in profits.

Those that held through May and sold at the end of the month would have done even worse, as since June 1 the SPY has gained over 12%. Experienced investors know that looking at each position is a better strategy than taking an all-in or all-out approach. Of course, stocks could drop back to the May lows but that does not look likely now.

In May’s article “Is This the Year to Buy in May?”I looked at five different election years and concluded that buying in May of an election year did often work, unlike other years.

For example, in 1936, stocks rallied over 18% from the May lows until the end of the year. This is an especially interesting year as the stock market and economy were recovering from the depression.

A very interesting NPR article, “When a Turn Toward Austerity Turned to Disaster," explains that the drop in unemployment from 22% to under 10% and high deficits prompted an austerity push by FDR. As they noted: “Over two years, FDR slashed government spending 17%.”

From the March 1937 high of 192.77, the Dow Industrials dropped to a low in March 1938 of 97.46. This was a decline of 49.4%, and was accompanied by a sharp rise in unemployment and plunging commodity prices. Ben Bernanke is obviously aware of this history, and probably hopes that last week’s action will help avert a similar fate.

There were several other good election years, with 1982 being the standout. From the mid-May lows, the Dow was up 32% by the end of the year.

NEXT: Now, a Reason for Caution

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The enthusiasm in the stock market needs to be tempered by the economic news, which still does not indicate a robust economy.

Just before the Fed’s announcement, the Organization for Economic Co-operation and Development (OECD) reported that it they saw additional signs of slowing in Italy, China, Brazil, Russia, and India in the coming months. There are also expecting weak growth in the two strongest euro economies, Germany and France.

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The OECD also reported on Friday that companies have cut back on international investment due to the economic uncertainty.

In the US, the economic data was mixed, as producer prices were up the most in three years, due in part to crude oil prices. The chart shows what appears to be an upside breakout, suggesting that this may be a trend that will continue.

The mid-month University of Michigan reflected a nice pickup in consumer sentiment. As the chart shows, it is near its best level in some time. The Royal Bank of Canada report on consumer sentiment hit a new high for the year, and their jobs outlook was the best it has been since President Obama has been in office.

Respondents also commented that they were benefiting from the Fed’s policy. This should be a positive for consumer sentiment and the retail sector, which I discussed last week.

Industrial production is still a concern, as last Friday’s numbers were weaker than expected. On Monday, we get the Empire State Manufacturing Survey, while on Thursday the Philadelphia Fed Survey and Leading Indicators will be released.

The latest numbers on housing come Wednesday, with housing starts and existing home sales data due to be released. Friday is triple witching day, which often corresponds with an increase in volatility.

NEXT: What to Watch

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What to Watch
Last week’s action in the stock market has improved the intermediate-term outlook, in my opinion, suggesting that we can be well above last week’s highs before the end of the year.

The longer-term analysis of the NYSE A/D line, as discussed on Friday, is one of the positive factors. Some of the other Advance/Decline lines had been lagging the price action, but they clearly improved last week.

On a short-term basis, the market is due for a rest. One or maybe two sharp down days could relieve the overbought status.

The sentiment of the newsletter writers is still too bullish, but they could be getting fully invested, and may be less of a factor over the near term. According to the AAII survey, taken after the Fed action, only 36% of individual investors are bullish, which is well below bullish extremes.

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Flows into equities were strong, as they were reported to be over $12 billion in the week ending last Wednesday.

This could be due in part to the decline in the bond market, as the Asset Performance chart shows that the performance of TLT has turned negative for the first time this year. In contrast, crude oil has moved back above the zero line for the first time since May.

If even a small fraction of the money that has moved into bonds over the past few years moves back into stocks, prices could explode on the upside.

Gold as measured by the SPDR Gold Trust (GLD) has moved well into double digits, while the Spyder Trust (SPY) is up over 17% for the year. It is interesting to note that the performance of GLD moved above that of TLT on August 16, when GLD closed at $155.63. On Friday, it closed at $171.86.

NEXT: Stocks and Tom's Outlook

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The buying strategy for the next few weeks will be to have some orders in place at good support where the risk can be well-controlled. I will be looking for those that have positive long-term relative performance and volume history.

Last Monday, I recommended two banks, Wells Fargo (WFC) and BB&T (BBT), which had just moved above long-term resistance. The buy level was hit in WFC. but missed in BBT by just 3 cents. Both closed well above the week’s lows. I will be looking for similar situations this week, as a market correction could come at any time.

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S&P 500
The Spyder Trust (SPY) moved above the daily Starc+ band at the end of the week. This makes some sideways action or a pullback likely.

The breakout level is at $143.20 (line a), with the 20-day EMA at $142.80. There is much stronger support in the $140 area, with the clearly rising 200-day MA at $135.27.

The S&P 500 Advance/Decline line was finally able to overcome the bearish divergence resistance (line b) that went back to the April highs. This is a positive sign, though we could see a retest of the breakout level on a correction

The 127.2% Fibonacci retracement target at $145.27 has been exceeded, with the 161.8% target at $155.65. There is also psychological resistance in the $150 area.

Dow Industrials
The SPDR Diamond Trust (DIA) has reached the trend line resistance (line c) that goes back to last summer. The long-term resistance from the 2007 highs is in the $137.90 to $141.95 area.

The Dow Industrials A/D line formed a negative divergence at the early May highs (line d), and this resistance has been overcome. The A/D line shows a flag formation (lined d and e).

There is first good support now at $133.40, with the 20-day EMA next at $132.34. There is more important support around $128.50 to $130.

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Nasdaq-100
The daily chart shows the breakout above the March-April highs, which was followed by a late push to the upside on Friday. The major 50% Fibonacci retracement resistance from the 2000 highs has been overcome, with the 61.8% resistance level at $81.70.

The Nasdaq-100 A/D line has overcome its downtrend (line b), but is still lagging the price action. The rally in the Nasdaq needs to become more broad-based for the A/D line to catch up with prices.

There is initial good support in the $68 to $68.50 area and then at $67.50.

Russell 2000
The iShares Russell 2000 Index (IWM) has put in an impressive performance in September, up 6.7% from the August close. This is likely a bullish sign for the overall market, as money is moving into the more speculative issues. Historically, a move into the small- and mid-cap stocks normally lasts several months.

The Russell 2000 A/D line peaked in February and formed a negative divergence later in the month. This bearish divergence resistance (line f) has now been overcome, and the A/D line is rising very sharply.

There is first support at $84.60 (line d), with additional levels at $82.85. Key support is now found in the $79 to $80 area.

NEXT: Sector Focus, Commodities, and Tom's Outlook

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Sector Focus
The iShares Dow Jones Transportations (IYT) came to life last week, as it was finally able to overcome its downtrend (line a). This is the first sign that it may be ready to get back in sync with the Dow Industrials, which was my concern in last week’s column.

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A close above the $95.60 level would be much more positive. The relative performance is still declining, and has not yet completed a bottom formation, as it is below the resistance (line b). The OBV is also below its resistance (line c). There is first support for IYT at $91.50.

The Select Sector SPDR Materials (XLB), which was up 3.6% the prior week, added another 3.8% last week, as the flag formation (lines d and e) has been clearly completed.

XLB has made new highs for the year, and next resistance stands in the $40 to $41 area. The relative performance has turned up sharply, but is still below its downtrend (line f). Volume has strong last Friday, but there is long-term OBV resistance at line g.

The Select SectorSPDR Financial (XLF) also had a good week, up 4%, while the Select Sector SPDR Energy (XLE) gained 4.3%. The Select Sector SPDR Consumer Discretionary (XLY) lagged, closing up only just over 2%.

Crude Oil
The November crude-oil contract made new rally highs last week, up $2.70 a barrel. The next likely target is in the $100 area, with major resistance waiting in the $108 to $110 area. Oil stocks are acting well, and I will be looking for more buy candidates in this sector this week.

Precious Metals
It was a powerful week for the metals. The December Comex gold futures surged $35.90 on Thursday in reaction to the Fed’s announcement.

The SPDR Gold Trust (GLD) closed above the 61.8% resistance level last week, as it closed the week up $3.40. The next major target is in the $174 to $175.50 area. The bullish sentiment has picked up on gold, and the Web is now full of articles on gold—quite a change from just a month ago.

The daily studies are positive for GLD and confirming the price action, so there are no signs yet of a short-term top. One is expected in the next few weeks, and it should provide a good buying opportunity in iShares Silver Trust (SLV) as well as another buying opportunity in GLD or IAU.

The Week Ahead
As I suggested last week, it is now clear that I was a bit too cautious over the past month. I focus on risk, and the preservation of capital is an important consideration.

I am now more confident that a correction will be a good buying opportunity. There are quite a few stocks that have not participated in the rally from the June lows.

For the rest of the month, I will be working to gradually become more invested, but right now is not the time to jump right in. I made some new recommendations last week, and materials, financials, and retail are three sectors I am now looking at closely.

For those who are not invested in the stock market, take a gradual approach—maybe 2% to 3% on any sharp down day—and work up to 20% invested. While this rally could last until the end of the year, next year may be very different.